“No time,
Always runnin’ here and
thereChasin’ the money…
Where are we runnin’
We need some time to clear our heads
Where are we runnin’
Keep on working ‘til we’re dead”
– Lenny Kravitz, Where Are
We Runnin’

My
profession is getting a big butt-kicking this week.In 1999, when we raised Greenstone’s funds, it
was soooo cool to be a
venture capitalist.Of course, when
we raised money, it was top of the technology market.Everyone wanted in.First
time fund managers like us were not only able to get
funds, some of our sources (the so-called Limited
Partners or LPs that are made up of mainly pension
funds) even bragged about doing first time funds.It’s easy to see why.Returns
were jaw dropping in early stage investing.Average returns were good, not just the top
performing funds.As it turned out,
those returns were short lived (1997 to 2000).Now, being a VC in
Canada
is as popular as a Microsoft Zune
player…

So
what happened this week?My Canadian
fraternity has seen their available capital to invest in
venture-type deals dwindle for six years in a row as
less capital gets raised every year (2006 was the lowest
amount raised for venture capital in 10 years!).April was one of the lowest months of investment
in early stage, following a meek first quarter.Also this week the CD Howe institute releases a
scathing report of the tax-credit based investment
vehicle also known as the
labour funds or LSVCCs.Theauthour reveals, among other
things, that if you leave in the cost of the annual
management fees, it appears that none of Canada’s 125
labour funds has a positive
rate of return to this point.Yikes.The investors have appeared to figure this out as
the amount raised by LSVCCs
in 2006 was down 25% from 2005.

It’s easy to take potshots at the
LSVCCs because their data is public.But the decline in new funds is prevalent across
the private funds as well.First and
second time managers are finding it nearly impossible to
raise new money in Canada because their returns are poor
and, like Greenstone, have no previous success to show
during the boom times.Returns are
not published, but data I have seen shows that the
aggregate private funds return over the last 15 years is
only marginally better than the
LSVCCs.It gets much better
if you only include the top five funds, however.

The
other huge trend that has venture investing in the dumps
is that there is an alternative investment for LPs that
is making them money right now: Private Equity.Of course, venture capital is a subset of private
equity, but VCs reliance on early stage technology as a
source of returns is what defines it.Technology markets have been steadily improving
since 2004.The NASDAQ is at or near
5 year highs.Profits are large and
growing.Employment is nearly full
in the technology centres.New technology markets like Web 2.0, digital
media and old ones like wireless are very hot.So why is early stage out of
favour?The answer is that it
isn’t out of favour, just in
Canada.US
early stage investing is up and access to capital is not
a problem for managers in the
US
(which declined by half since 2000, leaving better odds
of getting money for the remaining managers).Even the
US
early stage technology funding is
hot, don’t count on them to save our bacon.They will continue to do later stage investing in
Canada, but very rarely
come in for the Series A rounds.

The
funny thing about capital, especially institutionally
managed capital, is that it is usually smart and follows
the returns.So, the main culprit in
the dearth of capital for investing in
Canada
is that the returns aren’t here.
There have been no blockbuster exits in
Canada for a while.The last really good pop was probably
Aspreva Pharmaceuticals
given the amount of time from investment to IPO and
subsequent solid share performance.
One good exit does not draw the capital.A trend has to develop.

The
decline in available VC in
Canada
is directly tied to the absence of consistent returns
and the availability of those returns in other
investment vehicles (private equity, the stock market,
etc.).But isn’t this a death spiral
for innovation in technology in
Canada?If there aren’t meaningful returns, the VCs don’t
get funds.If the VCs don’t get
funds, they don’t fund innovation and the returns get
even worse…

I
have talked in this space before about the smaller
average exit price for Canadian M&A as compared to the
US.
Brightside is a recent example of a company exiting
early to the benefit of its angel investors, but not
generating breathtaking returns that make institutional
people take notice.The institutions
have tons of money to invest and need it to help create
some very large companies like RIM, MDA and PMC-Sierra
in order for their invested dollars to get a return.

So
who’s at fault for the poor returns in
Canada then? More
importantly, is there a fix?

Is
it the entrepreneurs?Are they not
thinking big enough?Are they
selling out too early?Are they not
stepping out a second or third time to try and make
money again?Are they inexperienced
in growing large companies (the perception from the
US investors)?

Is
it the investors?Are they making
bad investments at bad valuations?
Are they starving the oxygen from some of these
companies by turning off the taps as soon as the CEO
stumbles once?Are they themselves
too small and too conservative to fund big ideas?

Is
it the
US
investment market and its preponderance to assume all
Canadian companies are not worth investing in? Is it too
tough for Canadian companies to compete against their
better funded
US brethren?

Is
it regional, not a national problem?
Have poor returns in Quebec
and way too many funds in
Ontario
dragged down the national average to the detriment of
bright spots like BC and Kitchener-Waterloo?{Our study from two years ago suggested that BC
had better returns for the period of 1995-2004 overall
than any other province and most US states.But that was aggregate and included those
companies that never received VC funding (some of the
huge exits didn’t have BC VCs in them, so while the
province did well, the VC returns might not have been as
great vis a
vis other provinces).}

All
interesting questions… and all probably contributing to
the problem.I am telling you this
in May 2007, but believe me,
those in the VC industry in
Canada
have seen this train coming for a couple of years now.With the release of the CD Howe report this week,
some more interest from government in
Ottawa will certainly be
generated.In BC, the BCTIA and the
provincial government have been concentrating on this
for some time.The new Renaissance
Fund is a positive step for getting some more capital
into BC without offering any tax incentives.It is a similar structure to that offered already
in the US and Australia that concentrates on giving
investors a chance at better returns, not a break on
their invested capital (like tax credits).The government can also look at capital gains
taxation and red tape on cross border deals as ways to
improve the situation in
Canada.

But
the government cannot fix everything.Nor can they do anything that will impact the
next couple of years.Everything
they should do will be long
term and needs to be thought out well with input from
all involved.In BC, that process is
working.

Some may argue that the lack of capital will help
generate better returns as less
companies get funded with more money giving them
a better shot at being huge.Q1
Capital Partners from Toronto
thinks that there are only 5 or 6 active VCs doing new
deals in
Canada at the early
stage right now.That may be a bit
low (I can count five in BC alone), but the point is
that the pendulum of investment has swung too far to the
side of a few VCs and will not help new companies get
funded.So our “return” eggs will be
in a very small basket for the next few years.The early stage industry and commercialized
innovation in
Canada will rest with a
smaller number of companies for a while.We all hope they do well.

While the LPs continue to ignore this class of
investment in
Canada and the
LSVCCs continue to see less
and less capital raised, we all need to hold our breath
and hope the cycle breaks with some solid exits.We can’t panic and institute quick fixes.We just have to wait and see and plan for longer
term capital solutions based on what the investors want:
returns.In the meantime, funding
your new company will be an interesting experience.If you are not yet cash flow positive, you would
be best to focus on angels if you aren’t getting the
immediate attention of local VC’s still actively
investing.

Letters From Last Time:

My article last time generated a lot of responses, some
very passionate.As a follow up, the
Shift Happens power point deck I referred you to was
awarded World’s Best Presentation by Slideshare.net last
week.I include here a sample of
what came back to me (some edited for brevity):

Hi Brent,

Here I am again. Thank you for yet another brilliant
article.

As a db architect deeply involved in educational
software I can only express my utter frustration with
education in North America.
It forces students to forget about everything else but
GPA. So they burn their energy on what they are talented
the least, just to get GPA right, hoping that eventually
high GPA will give them the opportunity to do what they
are talented for. For most, it’s a pipe dream. As a
consequence all good positions are occupied by people
that ere good at… well having high GPA. They’ll make
future curriculum and future criteria. Guess what is
going to be high on their agenda? Political correctness
regarding social and racial issues emphasises GPA even
more.

On the other hand I have new comp science graduates that
were thought that relational databases were matter of
the past. They have to face harsh reality that they
can’t use their university knowledge because the
industry isn’t where they were told it would be. There
is a risk in going ahead of curve as well.

Dragan Babovic

…

Hi
Brent, thanks for writing a very thought provoking
article. Those of us in the late 30’s or early 40th
age group have lots to think about in terms of preparing
our children for the new demands in the world.

Also as a business owner, I certainly agree that we have
to be much more nimble on our feet to bend and flex to
what the market demands of our products and services. I
worry personally that the decline in University
enrollment in the math and sciences and engineering
areas here in
Canada is further going
to hinder our ability to attract good talent and compete
in the world marketplace.

…

I
just picked up the World Is Flat and can’t wait to read
it.

Appreciate your column.

Brenda Enegren

…

Thanks for your article on “Shift Happens”

I indeed found the presentation thought-provoking. Your
comments are dead on – my kids are older than yours
(Grades 11 & 9), and I find it increasingly difficult to
provide guidance as they approach university age, other
than to “be adaptable as heck!”.
Hopefully, moving them and forcing them to deal with
changes to their environment will have helped, but as
for deciding what to study, where to study, even whether
to study (just kidding?), it’s not as clear cut as it
used to be. I’ve forwarded the link to them – it will
be interesting to see how they react!

Regards,

Victor Holysh

…

You
are quite right in noting the need for more education in
business. Even in my own, mainly science based
education, there was never
any dealing with how science fits into the economic
framework locally, nationally, or internationally. Our
educational system could be much more integrative in its
approach to producing a more
well-rounded and informed individual capable of
focused application when needed. I have met some young
people who seem to have already gotten this, so it is
possible.

More than anything, I guess, The Next Shift, due to its
unpredictability, should, in my humble opinion,
encourage an evaluative and flexible posture
or , 'open preparedness', as
I call it. Too often it seems time/money/effort is spent
trying to predict and get ready for specific
circumstance that either does not arrive or passes on
all to soon, maybe a waste. Perhaps the most innovative
idea we can learn from the last decades of
transformation and proliferate towards the future is...
'Learn To Innovate'. I think if you look at
China
and
India, industry and
education, through that lens you will find they really
are not doing much better, if at all, compared to us.
They may think engineers and honour
students are the thing to produce, but that might not be
so in ten years and then what happens to all those
people, hmmm... we have seen here in
North America
the horrors of down-sizing and multinational corporate
migration. I think The Next Shift is going to see a lot
more of that, making prediction at the very most,
transient.

But, hey, at least we are out of the era of going down
to the local sooth-sayer to
get a prediction from mucking around in some animal's
entrails! I don't think many want to go back to that,
just like I don't meet many who want to go back to using
a typewriter.
ForNow
E LAMB

Something Ventured is a bi-weekly column designed
to supplement the T-Net British Columbia web site with
some timely, relevant and possibly irreverent insight
into the industry. I hope to share some of the
perspective and trends that I see in my role as a VC.
The column is always followed by feedback (if its
positive or constructive. I'll keep the flames to
myself, thanks).